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The Profit Surge Seems To Be Gaining Strength...

May 24, 1992

Economic Trends

THE PROFIT SURGE SEEMS TO BE GAINING STRENGTH...

There's more than a small chance that Corporate America's profit performance this year could be significantly stronger than anticipated a few months ago. One hopeful sign is the upbeat tone of first-quarter profit reports. Only a few weeks ago, it appeared that the profits of publicly held companies would post a collective 5% rise over their year-earlier level. Now, business week's survey of 900 companies indicates that reported profits before extraordinary items were up 7% last quarter.

The pickup is clearly gathering steam. According to Commerce Dept. data, operating profits, or corporate profits adjusted for inventory changes and excessive depreciation, posted their fourth consecutive quarterly increase in the final quarter of last year and were up nearly 7% over their cyclical low. While Commerce won't release profit numbers for the first quarter of this year until the end of May, economist Gregory Gieber of Smith Barney & Co. says that the government's advance report on first-quarter gross domestic product implies that operating profits were running a handsome 14% above their pace in the first quarter of 1991.

The hardest evidence of the profit surge is the latest report on corporate income tax payments to Uncle Sam (chart). Even with companies' efforts to minimize their tax burdens, the April tax take, which reflects corporate estimates of first-quarter liabilities, was up $1.1 billion, or 7.4%, from its year-earlier level. "That's the largest dollar increase for the April payment in half a decade and the biggest percentage gain since 1989," notes economist William Sullivan Jr. of Dean Witter Reynolds Inc.

Several factors lie behind the improving profit picture. Debt-servicing costs are down as a result of debt reductions, refinancing, and falling interest rates. Corporate restructuring and cost-cutting have produced leaner, more productive work forces: Smith Barney's Gieber calculates that nonfarm private-sector productivity rose at a 2.3% annual rate last quarter. And as costs have been cut, a lid has been kept on wage inflation.

The annual pace of gains in compensation, for example, has fallen to a mere 3.1% over the past year, and average hourly earnings at last count were running just 2.5% above their year-earlier level. Major collective-bargaining settlements concluded in the first quarter called for average wage increases of only 3% a year over the contract periods, compared with 3.2% in the contracts they were replacing.

All this bodes well for a profit recovery. As Gieber puts it: "If profits can advance smartly during a period when volume growth is lackluster and business lacks the ability to boost prices meaningfully, what will happen when the recovery accelerates and volume gains allow even better pricing power?"

His answer: a 17% rise in operating profits for the Standard & Poor's 500 this year. That rise, plus a sharp drop in write-offs, which depressed s&p 500 earnings last year, translates into a total profit gain of close to 50%.GENE KORETZ